In This Article:
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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use SJM Holdings Limited's (HKG:880) P/E ratio to inform your assessment of the investment opportunity. SJM Holdings has a price to earnings ratio of 17.79, based on the last twelve months. That is equivalent to an earnings yield of about 5.6%.
See our latest analysis for SJM Holdings
How Do You Calculate SJM Holdings's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for SJM Holdings:
P/E of 17.79 = HK$8.96 ÷ HK$0.50 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, SJM Holdings grew EPS by a whopping 45% in the last year. And earnings per share have improved by 7.5% annually, over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high. In contrast, EPS has decreased by 32%, annually, over 5 years.
How Does SJM Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, SJM Holdings has a higher P/E than the average company (15.5) in the hospitality industry.
SJM Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.